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Why Infrastructure Funds Look Shaky

Stan Luxenberg

NEW YORK (TheStreet) -- During the volatile markets of the past year, infrastructure ETFs collapsed. PowerShares Emerging Markets Infrastructure(PXR)lost 27.6%, trailing the average diversified emerging markets fund by 10 percentage points, according to Morningstar. EGShares China Infrastructure(CHXX) lost 20.7%, while EGShares India Infrastructure(INXX)declined 33.7%. Infrastructure funds in the developed world also recorded uninspiring results.

Can the funds rebound this year? Probably not, says Paul Baiocchi, an ETF analyst for IndexUniverse.com. "The uncertainty about government spending on infrastructure is wreaking havoc on these funds," he says.

The infrastructure funds invest in companies that build or operate power plants, highways, and bridges. The funds began appearing as the financial crisis unfolded. At the time, many countries were announcing big infrastructure spending projects that were designed to stimulate economies. Wall Street firms issued reports saying that infrastructure spending would surge for the next 20 years. Pensions and institutions began pouring into infrastructure investments. Analysts argued that infrastructure stocks could be relatively stable holdings because most investments relied on long-term projects with government backing.

But lately the outlook for infrastructure spending has grown more subdued. Weakened by the eurozone crisis, European banks--a major source of financing for projects-- have been forced to cut back on lending activities. With Congressional Republicans resisting stimulus spending, there is little prospect for a big increase in U.S. infrastructure spending. While China recently announced plans to increase spending, many emerging economies are exercising caution. "It doesn't appear that governments of emerging markets are in a position to embark on huge stimulus programs," says Paul Baiocchi.

Among the better performing infrastructure ETFs lately is SPDR FTSE/Macquarie Global Infrastructure 100(GII), which focuses on the developed world. During the past year, the fund lost 4.2%, outdoing the MSCI World index by 2 percentage points. The SPDR ETF has proved relatively stable in downturns. According to Morningstar the fund has a downside capture rate of 51%. So if the market dropped by 10%, the fund would typically lose 5.1%.

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But the SPDR ETF may not be an ideal choice for investors who want to hold a broad mix of infrastructure stocks. The problem is that the fund has 83% of its assets in utilities. In many respects, the SDPR infrastructure fund is very similar to pure utilities funds, such as iShares S&P Global Utilities(JXI). Of the top ten holdings in the infrastructure fund, eight are in the iShares utilities fund. Names in both funds include such blue- chip power companies as Exelon(EXC) and National Grid(NGG).

Even if the outlook for spending on highways and bridges is uncertain, there is still a good case for holding utilities. With demand for gas and power steady, utilities stocks tend to pay solid dividends and deliver consistent earnings. For investors seeking a utilities fund, the SPDR infrastructure ETF makes a sound choice. The fund yields 4.7%. During the past three years, it has returned 5.2% annually, outdoing iShares S&P Global Utilities by 2 percentage points. Part of the reason for the gap is that the iShares fund has 33% of its assets in poor-performing European markets. The SPDR fund only has 28% of assets in the troubled region.

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A broader infrastructure fund with a decent record is iShares S&P Global Infrastucture(IGF), which has 41% of assets in utilities, 20% in energy, and 37% in industrials. Holdings include Spectra Energy(SE), an operator of gas pipelines, and Dominion Resources(D), a Virginia power producer. Because of the energy and industrial holdings, iShares S&P Global Infrastructure is more volatile than the SPDR competitor. During the past year, the iShares fund lost 7.4%. But industrial stocks provided a boost in the rally that began in 2009. During the past three years, the iShares fund returned 8.2% annually, outdoing the SPDR infrastructure fund.